The rumours about Italy’s exiting the euro area sent EUR/USD down to five-month bottom

The single European currency dropped down to five-month low against the US dollar amid the rumours to the effect that Italy is going to exit the euro area. The draft coalition agreement between Five Star Movement and the League suggests certain technical procedure, allowing the republic to get rid of euro and restore its monetary sovereignty. Rome may demand from the ECB to cancel €250 billion of debt, which, according to the coalition, will decline their GDP by 10 basis points. Currently, Italy’s debt covers 130% from GDP. If euro skeptics mange to form the government, its policy will be similar to that of the Greek’s party Syriza during its first years in power.

Although, Italy’s economy looks stronger than the Greek’s one, Rome and  Athens have a very important common feature – debt burden. Its ratio to GDP has substantially widened since the Eurozone started functioning. It requires fiscal consolidation measures and slows down GDP growth.

 

Dynamics of debt-to-GDP ratios

Source: Bloomberg

Yes, currently, Italy will hardly exit the currency block, but the rumours to its effect can influence investors and consumers’ sentiment and finally result in GDP decline. And what the effects for bulls can be, we witnessed in April-May after the Old World's poor economic performance in the first quarter. Non-residents are already withdrawing their funds from the republic, which results in the stocks decrease and an increase in bond yields. Their spread with Germany’s counterparts has widened to the highest points since the parliamentary election in March, which is the evidence of growing political risks in the euro area.

The situation is worsened by a decline in consumer prices from 1.3% to 1.2% and core inflation from 1% down to 0.7% YoY in April; so the ECB monetary normalization is questionable, and euro is put a pressure on.

Dynamics of European inflation

Source: Financial Times 

Dollar, on the contrary, is supported by even those who were very skeptic a few weeks ago. Societe Generale calls the greenback "the king of the market" when it is supported by growing bond yields, as well as the chances of the Fed’s monetary restriction. The bank reminds that last time, when there was something like that, the greenback bulls were stopped only by a huge decline in the US stock indexes. The US dollar could be called a new Fear Index, as the developing countries’ national currencies are very responsive to its dynamics.

Dynamics of MSCI EM and USD index

Source: Bloomberg

Investors are selling out EUR/USD, for the currency block might break down, and the Eurozone economy looks rather poor against the Treasuries yield growth. The pair is steadily moving towards the convergence zone 1.165-1.175, and I still don’t know what could stop it. Failure of negotiation between Washington and Beijing? Escalation of the conflict around the Korean Peninsula? In mid-May, these bulls’ arguments look flimsy.


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Price chart of EURUSD in real time mode

Euro: All Roads Lead to Rome

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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